Earnings Call Transcript - MLKN Q1 2022

Operator, Operator

Good evening and welcome to Herman Miller's First Quarter Earnings Conference Call. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Antonella Pilo, Vice President of Investor Relations and FP&A. You may begin.

Antonella Pilo, Vice President of Investor Relations and FP&A

Good morning. Joining me today on our first quarter earnings call are Andi Owen, Chief Executive Officer; Jeff Stutz, Chief Financial Officer; John Michael, President America Contract; Debbie Propst, President Global Retail; Chris Baldwin, Group President MillerKnoll; and Kevin Veltman, Senior Vice President, Integration Lead. We have posted the press release on our Investor Relations website at hermanmiller.com. Wherever any figures are presented on a non-GAAP basis, we have reconciled the GAAP and non-GAAP amounts within the press release. Before I turn it over to Andi for a brief overview of the quarter, I would like to remind everyone that this call will include forward-looking statements. For information on factors that could cause actual results to differ materially from these forward-looking statements, please refer to the earnings press release as well as our annual and quarterly SEC filings. Any forward-looking statements that we make today are based on assumptions as of this date, and we undertake no obligation to update these statements as a result of new information or future events. At the conclusion of our prepared remarks, we will have a Q&A session. Today's call is scheduled for 60 minutes. With that, I'll turn the call over to Andi.

Andi Owen, Chief Executive Officer

Thanks, Antonella. You guys clearly know that I am at home today with my son and family, so welcome to my world. Good evening and thank you for joining us. This is an exciting day. We finalized our acquisition of Knoll in the first quarter, and today we are discussing our results as MillerKnoll for the very first time. Herman Miller is now doing business as MillerKnoll, and we're seeking shareholder approval at this year's annual meeting to change our name officially to MillerKnoll, Inc. Before I turn the call over to Jeff, I wanted to share a few remarks about our overall business and the progress we're making on the integration. Jeff will then take you through our financial results in greater detail, including changes to our reporting segments. We started the year with positive momentum and really strong demand globally. Q1 orders grew across every segment of our business. This positive order demand indicates the strength of our business fundamentals, as well as our strategy, and underscores our confidence in the future. Our teams are executing and driving progress against our strategic priorities. Both our retail and contract businesses continue to grow. We are bringing new customers to our brands with growth initiatives like gaming, store and studio openings, and a growing digital presence worldwide across all segments. As MillerKnoll, we're now one of the largest and most influential design companies in the world, positioned to redefine modern design and transform our industry. With a broader portfolio of complementary brands, enhanced scale and capabilities, and the financial strength of our diversified businesses, MillerKnoll is uniquely positioned to imagine and create beautiful design solutions that both endure and inspire. Since the early days of the integration, our global teams have demonstrated extraordinary operational discipline. They're executing well against our plans, and they're on track to achieve our timeline for delivering $100 million in cost synergies within two years after the close of the deal. One key area of focus for the integration is bringing our two leading contract dealer networks together in the Americas. While there's still a lot of work to do, we've made considerable progress and I wanted to share a brief update with you. In order to grow our contract business, we’ll enable our dealers to bring the collective capabilities of MillerKnoll and our industry-leading product portfolio to our customers. We'll create a network of MillerKnoll dealers to represent all of our brands. This strategy benefits our dealers by giving them access to the full power of our portfolio, which was a key driver of the deal, and provides opportunities for them to sell more and be better positioned to meet the specific needs of each customer. While this work focuses on the MillerKnoll dealer network in the Americas, the strategy also presents new opportunities for our international dealers as we bring Knoll’s amazing portfolio to these markets for the first time, unleashing incredible opportunities for growth. This strategy benefits our customers as well by creating the highest performing dealer network with access to the broadest product portfolio in the industry. The MillerKnoll network will have more dealers than either network had on its own, giving our customers more choices in terms of products and partners. Clearly, the MillerKnoll dealer network is not a one-size-fits-all approach and instead requires working market by market to determine the optimal footprint based on the unique dynamics of each one. We've established the principles we’ll use to determine the right distribution model for each market and we’re finalizing the optimal footprint for each of our key markets now. At the same time, we're developing the pilots and processes that will enable us to bring the combined MillerKnoll product portfolio to all of our dealers as soon as possible. This is based on our integration timeline, and it will continue to be a top priority for us for the remainder of the fiscal year. As we’ve said all along, bringing these two incredible organizations together felt like our destiny. Now that we’re on our way, we feel even more strongly that this was meant to be. Watching our teams from around the world come together to identify and capture the best in each organization while designing the path to our shared future is truly inspiring, and we know there's tremendous opportunity ahead of us. With that, I'll turn it over to Jeff to provide a bit more commentary about the results before we open it up for questions.

Jeffrey Stutz, Chief Financial Officer

Great, thanks, Andi. I'll start by seconding your comments about the integration. It has been really inspiring to watch this work unfold, and our teams are exceeding our expectations. Given their efforts, we're confident in our ability to deliver on our synergy targets. As we discuss results today, a quick reminder that our reporting segments have changed now that the acquisition is complete. As MillerKnoll, we will be reporting results under four business segments: Global Retail, which reflects the legacy North America Retail segment and now includes our International Retail business; Americas Contract, which reflects the legacy North America Contract segments combined with Latin America and the Design Within Reach Contract business; International Contract, which reflects contract business outside the Americas; and Knoll, as the acquired Knoll business will initially be reflected as a standalone segment. Earlier today, we issued a Form 8-K that provides historical information based on these revised segment definitions to assist you in your modeling and analysis. So, on to the numbers, consolidated net sales of $789.7 million were up 26% from the same quarter last year, which is an increase of approximately 0.4% organically. Keep in mind that we're facing a challenging year-over-year comparison due to the elevated backlog from COVID-related manufacturing and retail studio shutdowns last year. Additionally, our ability to ship orders this quarter was impacted by the supply chain disruptions our industry is facing. While we do expect this to moderate over time, our outlook for Q2 considers the near-term impact of these pressures. Orders were up 65% over last year or 35% organically. As Andi mentioned, strong demand was seen across all segments. Global Retail had another strong quarter with orders up 22% over the prior year period. The Americas Contract segment saw orders increase by 43% over last year, and International orders were up 35%. Knoll's Workplace business also saw positive order momentum, with leading indicators in this business consistent with what we observed in the Americas business, with the funnel of new projects up 18% and 14%, respectively, from last year. Knoll's Residential business also experienced strong order growth in both North America and Europe. Adjusted gross margin for the quarter was 35.9%, compared to 40% in the prior year period, impacted by higher commodity costs and other inflationary pressures. The previous year also reflected favorable channel mix associated with retail activity, operating leverage from working through elevated backlog, and temporary cost reductions as we addressed the challenges of COVID-19. To be sure, we are actively managing what we can control to address inflationary pressures going forward. We implemented a price increase this quarter and have additional increases planned for the second quarter to help offset these pressures. Adjusted operating margin was 6.2%, compared to 15.3% in the prior year. Similar to net sales, operating margin last year was higher due to shipments of elevated backlog at the beginning of the quarter, favorable channel mix, and the spending reductions we implemented to navigate the pandemic. We reported a net loss per share of $0.93, compared to diluted earnings per share of $1.24 for the same period a year ago. This includes the impact of additional shares issued in the first quarter, as well as a $1.42 per share related to non-comparable items. Adjusted earnings per share were $0.49 in the first quarter compared to $1.24 last year. Looking ahead to the second quarter, our guidance includes the full impact of Knoll for the quarter. We expect sales in the second quarter to range between $1.025 billion and $1.065 billion, and adjusted earnings per share to be between $0.55 and $0.61. This guidance considers a near-term inflationary and supply chain environment we're currently experiencing and the actions we're taking to help mitigate these pressures. The strong demand environment and traction from our strategic initiatives position us well as we look forward. With those opening comments, I'll turn it back over to the operator and we'll take your questions.

Operator, Operator

Thank you. Our first question comes from Greg Burns with Sidoti & Company.

Greg Burns, Analyst

So just, first, in terms of the inflationary pressure. What was the amount of the price-cost gap this quarter? And what's your line of sight on closing that given the cadence of the price increases you've instituted?

Jeffrey Stutz, Chief Financial Officer

Let me take a step back and give you a sense of the year-over-year impact in basis points terms because this might help unpack the crux of your question. Without a doubt, the big gross margin pressure we felt came from three inflationary components: commodities as one basket of impacts, commodity inflation eroding gross margins to the tune of about 120 basis points compared to last year. The key factor here was steel, which likely doesn't surprise you, but we saw inflation across almost every material category. The second bucket to point out is freight and delivery charges; while they affected us more late in the quarter than early, overall freight and delivery negatively impacted us by about 70 basis points year-on-year. The last component is labor-related inflation, which totaled about a 90 basis-point impact. These are the three components. Hopefully that gives you the color you're looking for.

Greg Burns, Analyst

Yes, but in terms of getting back to price-cost neutral, what's your line of sight on closing that gap?

Jeffrey Stutz, Chief Financial Officer

Here's what I would tell you: I mentioned in my prepared remarks, we on the legacy Herman Miller side of the business implemented a price increase back in June. The Knoll business did one in May. Additional increases have already been announced for October and November, upcoming. In the contract side of the business, these price increases will take some time to layer themselves into the gross margin. However, we are having conversations about whether current commodity levels will be sufficient. After about three months, we typically start to see some incremental benefit from those increases, mainly on the contract side of the business. Our guidance reflects some of that, but it will really be after the first of the calendar year that we start to feel the significant impacts. The retail business is different; we can do pricing more in real time, and Debbie and her team have looked at that and implemented some pricing as well.

Greg Burns, Analyst

Okay. And then on the supply chain issues, I guess there's a $30 million headwind this quarter. Is that what's implied in the guidance? Are you still expecting that type of order delays next quarter due to supply chain?

Jeffrey Stutz, Chief Financial Officer

In general terms, yes, Greg. We do not anticipate these pressures abating anytime soon, at least, not in the second quarter. Order of magnitude, maybe even a bit more than that, because we're picking up the Knoll business for an additional 6.5 weeks. So I would say that’s a fair assumption.

Greg Burns, Analyst

Okay. And then the demand, the order numbers were really strong. I don't know if 700 or 750 for the core business is a record number, but it’s the highest I think I've seen since I've covered the company. The orders are obviously very strong. Can you just talk about the cadence of the order patterns throughout the quarter? And what we've seen into the early part of this quarter? Have you seen any pull forward in orders, given the number of price increases that have been instituted?

Jeffrey Stutz, Chief Financial Officer

I'll start this one, then the business unit leads can chime in if they have specific commentary. I do not anticipate that there has been much pull ahead into the first quarter. The cadence of orders was strong in June right out of the gate. The Americas segment started the quarter quite strong. We saw positive results across all business segments in strong double digits every month of the quarter. The quarter ended maybe not quite as strong as it started in June but picked up from a bit of a lull in July. We ended the quarter with some pretty good momentum across each business segment. John, do you want to add any color?

John Michael, President America Contract

Sure. Jeff. Thank you. I would agree. In terms of pull ahead, I don't think we really saw any. In June, maybe a little bit of pent-up demand as back to work ramped up at that time. However, we've seen fairly steady cadence and order patterns through August and the first part of Q2 thus far.

Operator, Operator

Our next question comes from the line of Rudy Yang with Berenberg.

Rudy Yang, Analyst

So first off, you stated that you believe you'll still be able to achieve $100 million as run-rate cost synergies in two years, with some of that coming from procurement and supply chain opportunities. I'm just curious about your thoughts on how current supply chain issues are affecting your ability to realize those synergies and why you remain confident that your timeline to realize these synergies won't get pushed back at all.

Andi Owen, Chief Executive Officer

It's a great question. We've done a lot of thorough and intense work on this, and we think many of these procurement and supply chain issues are point-in-time challenges, and we're certainly not going to take just one round at it. We have a couple of years to achieve these synergies, and we see opportunities arising from both scale and reach in our supply base. The more we've looked into it, the more confident we've become. While it’s challenging now, we don’t think it will deter us from focusing on the long-term in a 24-month period.

Kevin Veltman, Senior Vice President, Integration Lead

Yes. Since we announced the deal, we've been working on integration planning, collaborating deeply with each team in each business unit to solidify plans and identify value capture opportunities. We reaffirm and feel more confident about delivering that $100 million within the two-year timeframe that we've discussed. We expect the mix to be pretty similar to our initial projections: about 40% will come from cost of goods sold and 60% from the SG&A side.

Rudy Yang, Analyst

Great. That's helpful. Secondly, you addressed how you started to integrate the dealer channels together. Is there more detail you can provide on expected dis-synergies and how you plan to mitigate these now that you've implemented the plan?

Andi Owen, Chief Executive Officer

Yes. As we modeled the deal, we planned for dis-synergies. We didn't specify where they would come from in the plan at this point. John Michael, since you're primarily in the Americas, would you like to elaborate on the dealer network?

John Michael, President America Contract

Of course, Andi. In mitigating dis-synergies, we’ve done a couple of things. First, we are taking direction from both customers and influencers, as well as dealers. We surveyed over 500 customers over the last 60 days and have had in-depth conversations with specifiers. We’ve leaned into the dealer councils of both Herman Miller and Knoll to understand the concerns we have received and respond. Our overall mindset is to ensure we provide a value proposition to our dealer network so they are aligned with the potential of what MillerKnoll can become. Listening to their needs and responding demonstrates our commitment to mitigate dis-synergies.

Rudy Yang, Analyst

Got it. And lastly, you said your net leverage ratio, including expected synergies, is about 2.3x right now. Is there any change to your target ratio and timeline for deleveraging towards that?

Jeffrey Stutz, Chief Financial Officer

No change, Rudy. We're focused on managing costs given the margin pressures we’re facing and the resulting impact on cash flow. We continue to believe we can delever to our target level one year forward from the close of the deal, and nothing at this point is throwing us off that path.

Operator, Operator

Our next question comes from the line of Steven Ramsey with Thompson Research.

Steven Ramsey, Analyst

I want to clarify my understanding here. The organic growth, can you talk about the organic growth of Knoll, 12% for just Herman Miller or did that include Knoll's organic growth? Could you clarify that for me?

Andi Owen, Chief Executive Officer

Hey, Jeff, do you want to start with that one? Then maybe we can turn it over to Chris?

Jeffrey Stutz, Chief Financial Officer

What I want to clarify is what I alluded to earlier regarding order growth. Steven, are you asking about year-over-year order growth?

Steven Ramsey, Analyst

Yes, I'm trying to gauge Herman Miller's organic growth and Knoll's organic growth.

Jeffrey Stutz, Chief Financial Officer

If you look at the legacy Herman Miller side of the business, for the full quarter, order growth recorded about 36% year-on-year with the Herman Miller components across three legacy segments. Knoll was consolidated into our group for a partial quarter, so for the 6.5 weeks, the order growth for that period was about 29%. However, on a pro forma basis, if you look back count the entirety of Q1 and compare it to the same prior-year period, Knoll's order growth was around 25%. Does that help?

Steven Ramsey, Analyst

That does, yes. Okay. Thank you for clarifying. And then, regarding Global Retail margins, what would you consider to be a fair margin level for retail with the impacts of inflation and investments happening right now? How do you see this evolving over the next 12 to 24 months as hopefully inflation moderates? How long do you expect elevated levels of growth investments to last, and how should we think about margins evolving?

Debbie Propst, President Global Retail

Hi, Steven, thanks for the question. Our margin rate in the Global Retail business for the quarter came in at 43.7%, compared to last year's 47.7%. Elements impacting the margin degradation from last year include product costs driven by raw material and labor increases that Jeff mentioned. Shipping costs and category mix also factored in, with category mix being a smaller piece of that margin trend. From an OpEx perspective, the increases are primarily driven by variable selling increases, occupancy for new stores, and content benefits. We’re making multiple investments in this business and will continue for the next 12 to 18 months as we rectify our infrastructure to support the current business model. Our existing infrastructure was built for a very different business model, which was primarily analog and showroom-driven. Now, it has shifted to an omni-brand, omni-channel model requiring a much more robust and dynamic infrastructure to support the business while enhancing our customer experience. We expect operating income to be in the low- to mid-teens during these investments.

Andi Owen, Chief Executive Officer

And Steven, just to add to this, we envision normalizing operating margins in the mid- to high-teens in the long run. To Debbie’s point, the investments we're making will continue over the next 12 to 18 months.

Operator, Operator

Our next question comes from the line of Reuben Garner with Benchmark.

Reuben Garner, Analyst

To start, Andi, I think you mentioned multiple choices in a single market from the dealers and how you're going to go-to-market with Herman Miller and Knoll. Is it too early to answer this? If you haven't communicated the strategy with the dealers, you can't tell us yet, but how will it work? Will the Knoll dealers now sell both Knoll and Herman Miller products, or will it be market-based? How will that decision be made? Will Knoll sell Knoll, and Herman Miller will sell Herman Miller for a period?

Andi Owen, Chief Executive Officer

These are all excellent questions, Reuben, and the answer to all of them is yes. We will have one dealer network, and every dealer will sell all of Miller and all of Knoll products. We are bringing them together so they can offer our entire portfolio. As part of this work, we’ve conducted extensive interviews with our customers and dealers, assessing each market's size to determine how many dealers are needed and where. We’ve been working on a market-by-market basis with our network to determine the right number of dealers. It's a thorough process that requires careful consideration. John Michael, would you like to add more?

John Michael, President America Contract

That’s a great summary, Andi. Just to reaffirm, we will have one MillerKnoll network selling the full collective of brands, with a tailored approach by market. It's worth noting that both Knoll and Herman Miller previously had markets with multiple dealers. We know how to navigate those situations and ensure it's mutually beneficial for all parties involved; we’re actively engaged in that process.

Reuben Garner, Analyst

So just to clarify, today if a company went in to buy office furniture from one of your dealers, would they be able to buy products from both the entire MillerKnoll suite?

John Michael, President America Contract

Not quite yet. We are in a beta test situation currently, where we're working on the mechanics of how that flow will operate. Our intent is to have everything in place by mid-2022, enabling each dealer to represent all brands.

Andi Owen, Chief Executive Officer

The good news is that all of our dealers sell products from multiple manufacturers today. Therefore, ordering from various manufacturers is not new for them. Our focus is on how we enable them from the back office and provide the right training on both product portfolios, so their salespeople can quickly get up to speed. This aspect is our number one priority right now, and we want to act swiftly.

Reuben Garner, Analyst

On the supply chain, it appears there's a significant ramp-up in your business across MillerKnoll from the current quarter to next quarter, at least on the top line. However, there seem to be ongoing supply chain headwinds. Can you clarify how you expect to increase revenue from around $900 million to something like $1 billion, especially considering you’re contending with supply issues and how this transition happens?

Jeffrey Stutz, Chief Financial Officer

We are indeed facing capacity constraints. While our operations team has done a great job mitigating the pressure, challenges remain. For example, we experienced COVID-related closures in particular key markets, notably India, which impacted our throughput activity in the International Contract business and acted as a drag on revenue. However, we anticipate a ramp-up in activity and our ability to produce and ship in Q2, all of which is reflected in our guidance.

Andi Owen, Chief Executive Officer

Keep in mind, we are entering this quarter with a robust backlog. Material availability is more constrained than labor. While labor challenges persist, conditions are gradually improving. This is also part of the narrative.

Reuben Garner, Analyst

Does the current demand environment and constraints you face influence your outlook on any potential footprint consolidation? Have you rethought any moves related to integration or either company’s standalone perspective?

Chris Baldwin, Group President MillerKnoll

Reuben, regarding Knoll, the consolidation has already taken place, which has been beneficial from a cost standpoint. This did not impact our production capability, although supply chain issues remain a general concern. No plans exist to close any facilities at this point; it’s about procurement and achieving our $100 million in savings as previously discussed.

Operator, Operator

Our next question comes from the line of Alex Fuhrman with Craig-Hallum Capital.

Alex Fuhrman, Analyst

Thanks for taking my question and congratulations on the Knoll integration. I wanted to ask about the retail business. There has been significant conversation about your corporate business, but now with the new reportable segments, it seems Global Retail is more than 25% of your sales and moving towards 30%. Could you share more about the strategy for this segment going forward? Specifically, I'm curious about the performance of your Herman Miller and seating stores as we move farther away from the depth of last year’s lockdowns, and if there’s an opportunity for continued new stores openings under the flagship brand in the future?

Andi Owen, Chief Executive Officer

I’ll turn this over to Debbie, our President of Retail, but our retail strategy has been bearing fruit. We’ve been very thoughtful about our direct-to-consumer business, focusing on delivering healthy and ergonomic seating amid the hybrid work environment. Herman Miller seating stores have been performing remarkably well and we see continued growth in our retail business. We believe we are just beginning to unlock the full potential of our retail segment globally.

Debbie Propst, President Global Retail

Our top priority is optimizing omnichannel customer journeys to ensure our brands present consistently, regardless of the channel the customer chooses for engagement. Additionally, we have strategies for each brand. For Design Within Reach, we are focusing on assortment expansion, driving significant growth from new units. Within Herman Miller, we have been working on improving awareness of the benefits of existing product lines, utilizing various omnichannel touchpoints with performance seating stores being critical to that effort. We opened three new locations in Q1 and added two more since, bringing our total to 11, and we aim to maintain a similar rate of openings this fiscal year. For HAY, as a younger brand, we are focusing on assortment strategies to bolster its presence in North America as a reliable resource for home décor.

Operator, Operator

We have a follow-up from Greg Burns.

Greg Burns, Analyst

Could you address the impact of office reopening on demand levels for home office and seating? Are you seeing any shifts in this area? Additionally, can you discuss the accretion you saw from Knoll this quarter and whether that’s what we should expect going forward?

Debbie Propst, President Global Retail

I'm pleased to report that our workspace category in retail channels continues to grow year-over-year, despite previous double-digit growth last year. This reinforces our resilient strategy amid the emerging return-to-office trends. One factor driving this is how we've repositioned our products to emphasize wellness benefits, improving overall work-life balance and health. This distinct positioning helps to maintain momentum beyond pandemic trends.

Andi Owen, Chief Executive Officer

Let’s not forget our successful gaming business, which is part of our seating segment and has immense potential. We have only scratched the surface of this lucrative market. Our innovations in that category will continue driving growth.

Jeffrey Stutz, Chief Financial Officer

Regarding your question about accretion, we were pleased to see some EPS accretion from the acquisition right out of the gate, despite it being a partial quarter. However, we should bear in mind that we didn't reflect the full drag of the weighted average share count. Expect to see the impacts from the Knoll integration when factoring in the higher debt also along with increased share counts to be neutral, possibly a slight drag on earnings per share in the short run. Looking forward, we maintain our view from the announcement date, we expect the deal to be accretive after one full year on a cash basis, adjusting for acquisition-related amortization, and on a GAAP basis after two years.

Greg Burns, Analyst

It appears that you haven’t seen a slowdown from the Delta variant and related postponements; businesses have been pushing back their return-to-office plans. Still, could you provide your insights? Have there been any impacts from COVID in your conversations with customers?

Andi Owen, Chief Executive Officer

I’ll let John and Chris weigh in on this. In general terms, project pushes are not unusual within our business. Throughout the last couple of years, COVID has driven a push-pull dynamic globally. We have seen some projects pushed, but in return, some have shifted from quarters into this one. The essential point is we are not experiencing cancellations, which is very encouraging, and demand is increasing as people think differently about their environments. Vaccines and mask mandates have built confidence this year compared to last for bringing people together more effectively.

John Michael, President America Contract

Clients we engaged with who were originally set to return in September and October have shifted to January or even March. However, these pushes have only been about 60 to 90 days—not long-term delays. Additionally, there is now clarity regarding the need for an office; clients recognize that collaboration, connection, and innovation require an appealing destination that promotes an attractive environment for employees. We view this as very positive.

Operator, Operator

I'm showing no further questions in the queue. I would now like to turn the call back over to Andi for closing remarks.

Andi Owen, Chief Executive Officer

Great. Thank you so much, everyone, for joining us today. We appreciate your continued interest in MillerKnoll and look forward to updating you again next quarter. Have a good night.

Operator, Operator

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.